Standard & Poor’s proposed a new rating methodology for local governments on Tuesday.
The chief changes would be to increase the emphasis on numerical sub-ratings, formalize the role of a state’s institutional framework, introduce weighting measures to emphasize the factors, and to formalize a flow pattern for the rating process.
S&P estimates that adoption of the rating methodology would lead to about 65% of the ratings remaining unchanged, 32% increasing and 3% decreasing. The results were found on a sample of rated governments using quantitative analysis only and so would not perfectly reflect the actual results should the methodology be adopted.
S&P is proposing the methodology for 8,300 U.S. local government general obligation bonds. It does not cover states or special-purpose districts like schools.
“The primary purpose of this criteria change is to increase transparency with respect to how U.S. local government GO ratings are derived and to enhance the comparability of U.S. public finance GO ratings with other sectors,” said Steven Murphy, managing director of the U.S. public finance state and local government group at S&P.
The new methodology would use the same general factors to rate government-issued debt, said James Wiemken, criteria officer at S&P. “The added transparency comes from the fact that we’re specifying how the underlying elements come together” and how they lead to a rating, he said.
In the new methodology, five general factors are analyzed: a state’s institutional framework, local economy, government management, financial measures, and debt and contingent liabilities. The new methodology also examines three specific components of the financial measures factor: liquidity, budgetary performance and budgetary flexibility.
Scores for each factor range from 1 (strongest) to 5 (weakest). The factors are given the following emphases: 10% for institutional framework, 30% for economy, 20% for management, 30% for financial measures, and 10% for debt and contingent liabilities. Each of the components of the financial measures factors gets a 10% weight.
All these scores are brought together to make an indicative rating from 1 to 5. Then certain positive or negative overriding factors are considered. Some of these may put a cap on the maximum possible rating. Others adjust ratings up or down a notch.
The overriding factors are: liquidity scores or management scores equaling 4 or 5, high per capita income, low real estate market value per capita, and measures of the ratio of the general fund balance to general fund expenditures.
S&P has sent out notice of a request for comment on the new methodology to 40,000 parties who are concerned with local government debt. The agency is taking comments on the methodology until June 6. It is not stating how long it expects to take to come out with a finalized new methodology.
However, in 2010 and 2011 it was about seven months from the time S&P issued a request for comment for a new state rating methodology and the time it adopted a finalized version.
The request for comment, with detailed explanation of the new methodology, can be found at www.standardandpoors.com/pfcriteria with the title “Criteria/Governments/Request for Comment: U.S. Local Governments: Methodology and Assumptions.” Comments can be emailed to email@example.com.
Michael Camarella, vice president at Oppenheimer Funds Rochester Group, says the new ratings methodology would be a good thing if it raised ratings on many bonds. Retail investors drive the market for munis. “If there are potentially large swings in ratings, these will drive retail demand,” he said.